Security deposits for commercial office leases vary widely and are dependent upon market conditions, lease terms and tenant credit. However, the primary determinant of a security deposit is the landlord’s “out-of-pocket” costs to effect the lease transaction. This amount will consist of the total of: tenant improvements funded by the landlord, free rent, legal fees and brokerage commissions.
1) One simple tactic to minimize the security deposit is to minimize the landlord’s costs by taking a space in its existing condition and forgoing a free rent period. (In addition to lowering the security deposit, this will also improve the monthly rent, as well). In today’s market, we guide our clients to be prepared to post a security deposit on this basis in the range of 3-6 months’ rent.
2) The maximum amount of security a tenant should offer is six (6) months’ rent. Here’s why: landlords are most concerned with non-paying tenants or squatters. According to most landlords, a squatting tenant can tie up a landlord in litigation for up to six (6) months. Therefore, If a tenant posts a six (6) month security deposit, the landlord’s risk can be thereby mitigated and any personal liability can be avoided (see #3 below). [Note: what landlords don’t recognize is that tech tenants are never squatters, as squatting implies that paid employees are occupying the space rent free… on the contrary, when tech startups implode, employees are usually let go well before the office space is vacated or surrendered..]
3) However, many landlords still fear the squatter and will request a limited personal (or “good guy” guarantee. Conceptually speaking, the limited or “good guy” guarantee is a personal guarantee for the portion of the lease term spent in occupancy, prior to surendering the space after default. If you want to avoid a personal guarantee, it may be necessary to offer an additional 1-2 months of security deposit. If you have to post additional security deposit to avoid a personal guarantee, we recommend negotiating a “burn down” or reduction of the security deposit over the lease term, so that at the end of the term the landlord only holds a reasonable amount (3-6 months’ rent). [Note: a “good guy” guarantee should not be confused with a termination option..for more detail on “good guy” guarantees, see our post on what a 'Good Guy Guarantee' is.
4) Security deposits should be in the form of a letter of credit (or “LOC”) from the tenant’s existing financial institution. This is preferable for both parties as, for the landlord, the security deposit cannot become a liquid asset of a potential bankruptcy court proceeding and, for the tenant, the security deposit funds never leave the tenant’s financial institution.
5) If you try these tactics and still can’t get the security deposit terms that you want, it may be worth considering another property. Every landlord is different and there are a wide range of lease terms that can be negotiated and some may be less stringent than others.